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July 1, 2013

Unprecedented Muni Deal Will Gut Investors in Alabama Sewer Project

Jefferson Counly, Ala., will pay hedge funds 80 cents on the dollar; most others will get much less

Participants in the $3.7 trillion municipal bond market that finances schools, roads and other projects are likely watching in dismay as some of their investments go down the sewer, literally.

The costly sewage system revamp in Jefferson County, Ala., looks like a raw deal for muni debt holders who, for the first time, according to Bloomberg, will be forced to accept a loss of principal.

The Southern state’s largest county, encompassing the Birmingham metropolitan area, filed a 101-page consensus-based plan in U.S. Bankruptcy Court on Sunday that includes a cut of $1.2 billion in principal payments to holders of sewer-related debt.

The Birmingham Business Journal quotes David Carrington of the Jefferson County Commission, which approved the plan, as saying the result reflects a hard-fought consensus between the county and its creditors:

"All of the various sewer creditors (the monoline insurance companies, the liquidity banks, the hedge funds, and particularly JPMorgan) will be getting far less than a full recovery. Every part of the settlement is the product of very intense, hard-fought, arms-length negotiations."

Should the plan win court approval, which Carrington considers likely following long negotiations since the county’s recording-setting $4.2 billion insolvency filing, the county will refinance its sewer debt, raise sewer fees on ratepayers and exit bankruptcy.

Not all participants will receive the same haircut. Hedge funds, who will participate in refinancing the county’s debt, will collect more than 80 cents on the dollar, Bloomberg reports, while JPMorgan will collect just $375 million of the $1.84 billion it is owed.

The New York bank was implicated in a number of questionable deals in an apparent bid to win the county's underwriting business, settling the case with the SEC in 2009 while neither admitting nor denying wrongdoing. County officials involved in the matter went to prison.

The Jefferson County case is one of several high-profile municipal bankruptcies that must be giving investors pause in recent years. Stockton, Calif.’s Chapter 9 filing last year made it the biggest municipality in history to go bust, though its $700 million debt load is dwarfed by Jefferson County’s $4.2 billion debt.

Now the city of Detroit looks set to dwarf both those records, with a 700,000-plus population more than twice the size of Stockton's and a debt load of more than $18 billion that the city’s appointed emergency manager is seeking to negotiate with creditors.

In an interview with AdvisorOne last week, Morningstar municipal credit analyst Elizabeth Foos said muni bond investors may be in danger of losing the front-of-the-line creditor position that such investors have historically assumed.

“By calling general obligation bonds unsecured debt, [emergency manager Kevyn Orr] puts it on par with pension liabilities and retiree health care," she said. "That begs the question of how much risk is really associated with general obligation unlimited tax debt in the state of Michigan.”